Gov solutions to positive externaities (underconsumption or underproduction) Flashcards
What happens when producers and consumers do not consider the external benefits of their actions ?
they end up under producing and under consuming
What is one way to solve the underconusmption and underproduction of goods ?
A subsidy
What is a subsidy ?
This is a grant from the goverment to a firm to increase supply
Why is education under consumed ?
Consumers only care about the private benefits towards them like having a higher income and a better job. They do not care about external benefits like reducing crime
How will the subsidy fix this under conusmption and under production of education ?
This would shift supply to the right, reducing costs of production, reduce prices and shift the market equilibrium to the socially efficent equilibrium
Can subsidy help with positive production externalities ? and give an example
For example in the housing sector the producers will only care about the private costs towards them and not the external benefits which would result in underproduction. A subsidy would increase incentives for suppliers to produce houses. Supply will increase and gets rid of the underproduction of houses
In what way can subsidies not help with externalities ?
For example, in the housing market as houses are necessities demand is price elastic. Therefore, even with subsidies producers would still sell at a higher price as they can gain more profit
What will the goverment do to solve this issue of subsidies not helping the underprod or underconsump of a positive externality good ?
They will introduce a maximum price
What is the maximum price ?
This is the highest price suppliers can sell a good for
Where do you plot the maximum price on the diagram and how will it help ?
You have to plot the maximum price below the equilibrium price as this way suppliers cannot legally increase prices back to the equilibrium.
What does the price being stuck at pmax create ?
It creates excess demand
How does disequilibrium help consumers ?
As it can help make products a lot more affordable for consumers
Where does the maximum price HAVE to be set at to work ?
It has to be set below the equilibrium price as it will prevent prices to go back up to equilibrium prices
How does the subsidy have to bet set by the goverment to be successful ?
The subsidy has to be set according to the size of the external benefit
